At a time when the British economic recovery depends on new business investment, bank lending to small business is shrinking and the price is rising.
It is an unfortunate paradox that well intended measures to secure our financial system are limiting the recovery and extending the pain. In their understandable zeal to respond to yesterday’s crisis, regulators resemble First World War generals hell bent on fighting the last war.
No one has much sympathy for the banks and there is no political dividend in supporting their cause. But hardly a week passes without another attack on bankers or new regulatory measure designed to reduce further returns for bank shareholders.
No one doubts that tougher regimes and a new culture and lower bonuses are required. But beyond a point it becomes an act of political indulgence - regulation and reserve capital does not come for “free”. It comes with a cost and the price of the attack on banks will be lower growth.
In the past month alone we have seen a further increase in the bank levy which is designed to transfer £2.5bn straight out of bank profits to the Treasury.
The Financial Policy Committee launched what The Daily Telegraph described as “the most intrusive bank intervention” since the bank bailouts of 2008. The Financial Stability Report called for a new level of caution in assessing bank balance sheets and by implication yet higher reserves. Andrew Tyrie’s Commission on Banking Standards has been having a field day eviscerating the bank bosses of a past era.
Politicians and media of every hue and complexion have fostered a more aggressive approach than in almost any other developed country. A toxic political climate has resulted in an attack on bankers and banking, some doubtless well deserved.
As well as higher regulatory capital requirements, banks have to hold more liquid assets on the balance sheet. On top of the Basel III capital requirements the 2011 Independent Commission on Banking’s ring fencing proposals will increase funding costs by between £1bn and £4bn by 2019. Other savings and insurance products are becoming less profitable as they are engulfed in the regulatory storm resulting from culpable mis-selling.
Regulators argue that safer banks can borrow for less and need a lower return for shareholders. Vince Cable last week blamed shareholders for “hopelessly unrealistic” expectations and argued that as “utilities” they should earn a modest return.
But today the underlying sustainable return on equity is well below even that level. Robert Hingley of the Association of British Insurers said only two weeks ago none of the major UK banks are “investable” and none are in a strong position to raise new capital.
Whichever way you look at it there is a huge net increase in bank costs only a small part of which is met by closing branches and laying people off.
Therefore banks will need to become more profitable. This means higher margins or less lending or both. Tiered capital requirements are a logical response to the migration of traditional banks into riskier areas of lending. But the effect may be to discourage unsecured lending to small business. Last year bank lending to companies fell by some 5.5pc.
It is not just the economics of banking that is reducing business lending. The culture of banking has gone into “safe mode”.
Banks are like oil tankers. They take a long time to build momentum and a long time to lose momentum. The shock of the downturn has injected caution into the system. The best bankers are working on retrieving problem loans not generating business. Lending to middle Britain is not conducted by the high rollers of investment banking but by an army of modestly paid regional bankers.
Today no branch manager gets fired for not lending enough to local car dealers. The excesses of the boom years are now matched by a caution that will take years to erode.
The huge increase in both amount and complexity of regulation will distort the balanced commercial risk taking that is at the heart of good banking. The firestorm of public disapproval has given carte blanche to every bureaucrat on the scene so the only part of the bank industry growing fast is the wealth destroying activity of financial regulation and compliance.
Andrew Haldane in his brilliant speech “The Dog and The Frisbee” draws a parallel between bank regulation and dogs catching a Frisbee. They do not learn by calculating Newton’s law of gravity. It is a skill and a judgment. So is bank governance and good governance derives from experience, culture and wisdom.
Formulaic regulation increases cost and removes the onus on judgment. The Basel I rules extended to 30 pages, Basel II rules to 347 pages and Basel III nearly double again to 616 pages. No wonder recruiters report steep declines in graduate applications for bank training schemes. No wonder bank chairmen report difficulty in persuading high callibre men or women to join bank boards.
And the costs of borrowing are already rising fast. If we assume, as Lazard research suggests (and it is a judgment), that the required increase in lending margins is roughly £1-4bn, including the bank levy this is the equivalent of a straight tax increase on borrowers. Most of this “bank tax” will fall on small business.
It is not the large corporates that are suffering. Large businesses, like ITV (Xetra: A0BLQP - news) , have strongly restored balance sheets and are keeping their powder dry. They can access international bond markets where rates are very low so the banks cannot recover margin from them.
It is the small businesses and entrepreneurs who will suffer. Go to any small businessman’s lunch in the North of England and the talk is of little else. Bank lending is not available and where it is the amounts are low and the rates are high. Capital rationing is here and here to stay.
Why does this matter? Not because we care about the welfare of bankers or the size of their bonuses. It matters because all the studies show that a sustained recovery from recession depends on the SMEs, the innovators and the entrepreneurs. The Office of Budget Responsibility’s own forecasts assume that business investment will drive the recovery and increase at double digit rates from 2015 onwards.
Of course the CBI and House Builders Federation are crying out for infrastructure spending and a planning free for all. But this recession is not like that of the 1930s or even early 1980s in the UK.
Employment has held up well and the private sector is already creating jobs. Infrastructure investment will not fuel the recovery. It takes a long time to undertake and a longer time to deliver.
So it is imperative to fund the hidden entrepreneurs and small businessmen that will drive our growth in the future.
And we have a latent army of entrepreneurs. Britain leads in Europe (Chicago Options: ^REURUSD - news) in the numbers and talent of our digital entrepreneurs, internet retailers, life scientists - but many I talk to are thinking of raising funds in the US. All the studies of entrepreneurship show that early stage finance is bank finance and it is not there.
The Government finds itself pulling both ways. The regulatory effect is reducing bank returns and increasing costs. So the Elastoplast has been applied in the form of the Bank of England’s funding for lending scheme. Whilst not a bad idea in principle it has been largely thwarted by the Government’s own regulation. Most of the take up has been used to fund secured mortgage lending which attracts a lower capital requirement.
Vince Cable is talking about introducing a business bank - a state controlled bank to finance lending gaps such as in so called “patient” long term capital or funding start up or “challenger” banks.
There have been sillier ideas, but the fact is there is very good infrastructure for lending already in place up and down the country. We don’t need to invent a new one. It just happens to belong to the banks that now seem to be regarded as the enemy. The old regional and branch networks are still there, they know the local businesses. This is exactly what the Bank of Scotland used to do before HBOS got hold of it. They need to be encouraged to get back to good old fashioned banking.
In reality bank balance sheets are, to a coin a phrase, “healing” and arguably a lot faster than the public finances. Bank policy should be counter cyclical. In other words encourage lending in the downturn and restrain it in the boom years. History may judge that we have achieved neither.
No one working at the top of a British bank is under any illusion that there has been a sea change in attitudes and rightly so. Balance sheets are contracting fast. The combined tier one capital of the UK banks is already higher than those of the USA, France, Spain, or Italy.
Poor quality loans are slowly being worked off. Exposures to euro crisis hit financial institutions (Ireland (Xetra: A0Q8L3 - news) apart) are lower than for years and amongst the lowest in Europe. All the major banks have seen wholesale changes in management and board membership. The risk of a major British bank failing today is slight. The risk of a collective failure to lend is high.
In short the direction of banking policy needs to reverse. The Government should hold its nose and recognise there is a time and place for everything and right now we need growth.
That means we need profitable banks. Low profit utility banks will not innovate, will take few risks, make poor judgments and slow economic growth. We need to balance economic dynamism with enlightened strong “macro” regulation. Intrusive regulation will never create the new culture or the pro-business lending that British banking needs. Strong leadership will.
Banks need time and space to become again the cautious financiers of the pre-boom era. It is time to call the dogs off the banks and let them get back to earning a living.
Archie Norman is the chairman of ITV.